Developing a performance management system to support supply chain management in an SME

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LAPPEENRANTA UNIVERSITY OF TECHNOLOGY LUT School of Engineering Science

Industrial Engineering and Management Master’s Thesis

Sanna Vainikainen

Developing a performance management system to sup- port supply chain management in an SME.

27.8.2018

Examiner: Professor, D.Sc. (Tech.) Timo Pirttilä

Instructor: Procurement Mgr., M. Eng. Otto Tynys, case company

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ABSTRACT

Author: Sanna Vainikainen

Title of thesis: Developing a performance management system to support supply chain management in an SME.

Year: 2018 Place: Lahti

Master’s thesis. Lappeenranta University of Technology, LUT School of Engineer- ing science, Industrial Engineering and management.

123 pages, 26 figures, 12 tables and 5 appendices Examiners: Professor, D.Sc. (Tech.) Timo Pirttilä

Keywords: Organizational culture, Management culture, Leadership, Perfor- mance management, Performance measurement, Performance management system, SME, Supply chain management, Project management and ERP

This is a constructive thesis aiming to implement a performance focused management culture to the case company, so that the case company can systematically assess its performance, develop processes based on knowledge and execute strategy in such way that it complies to ISO 9001 quality standard. To support performance management, this thesis defined a performance measurement dashboard, which was tested in teams involved in project division’s supply chain. This thesis assesses managerial first impressions with a structured interview and uses this information to identify success factors for rolling the management practices to the rest of the organization.

This thesis positions performance management to a much larger quality management context and treats performance measurement as one of the most significant tools of performance management. Literature review examines alternative ways to construct a performance measurement system, set goals and manage performance.

Examples provided in this thesis are focused on supply chain aspects of the business, as the supporting tools of performance management were tested in supply chain teams.

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TIIVISTELMÄ

Tekijä: Sanna Vainikainen

Työn nimi: Suorituskyvyn johtamisjärjestelmän kehittäminen pk-yrityksen tilaus- toimitusketjulle.

Vuosi: 2018 Paikka: Lahti

Diplomityö. Lappeenrannan teknillinen yliopisto, LUT School of Engineering Sciences, Tuotantotalouden koulutusohjelma.

123 sivua, 26 kuvaa, 12 taulukkoa ja 5 liitettä.

Tarkastaja(t): Professori, TkT Timo Pirttilä

Hakusanat: organisaatiokulttuuri, johtamiskulttuuri, johtaminen, suorituskyvyn johtaminen, suorituskyvyn johtamisjärjestelmät, pk-yritys, toimitusketjun johtaminen, projektijohtaminen, toiminnanohjausjärjestelmät

Työn tarkoituksena on jalkauttaa kohdeyritykseen suorituskyvyn systemaattiseen analysointiin ja johtamiseen painottuva kulttuuri, joka auttaa yritystä kehittämään liiketoimintaprosessejaan sekä toteuttamaan strategian mukaista toimintaa tavalla, joka tukee ISO 9001 laatustandardin käyttöönottoa. Työssä määritellään suorituskyvyn johtamisen tueksi suorituskykymittaristo, joka pilotoidaan projektiliiketoi- minnan toimitusketjuun osallistuvissa tiimeissä. Työssä selvitetään strukturoiduin haastatteluin kokeiluun osallistuneiden johtajien ensivaikutelmia suorituskyvyn johtamisesta ja sen tueksi tarjotuista työkaluista. Näiden ensivaikutelmien perus- teella pyritään tunnistamaan keskeisimpiä tekijöitä, jotka tulee ottaa huomioon jal- kauttaessa suorituskyvyn johtamisjärjestelmä koko organisaatioon.

Työ käsittelee suorituskyvyn johtamista osana laajempaa laatujohtamisen käsitettä ja asemoi suorituskyvyn mittaamisen yhdeksi suorituskyvyn johtamisen työväli- neeksi. Teoriaosuus käsittelee vaihtoehtoisia tapoja suorituskykymittariston raken- tamiseen, tavoitteiden asettamiseen ja suorituskyvyn johtamiseen. Työssä anne- tuissa esimerkeissä korostuu toimitusketjun näkökulma, sillä suorituskyvyn johtamisen työkaluja testattiin toimitusketjussa.

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Acknowledgements

I would like to thank everyone who has walked alongside with me during this a bit longer than a half year project. Firstly, I want to thank the case company, moreover former CEO Jussi Teijonsalo, who gave me this opportunity to research such an interesting topic. This master’s thesis is done for a company where I have worked for more than a year and a half. It has been an amazing journey for a young professional like me to work in such an open environment where newcomers get a lot of responsibility and a chance to truly develop their skills.

Then I would like to express my special thanks to Otto Tynys for all the help and encour- agement as my supervisor and as the instructor in my thesis. Otto has been a lot more than just an instructor in this thesis project, he has guided me and given me so many rewarding assignments, projects and career advises that have meant the world to me. Thanks to Otto, I am able at such young age to be absolutely sure in what direction I want to go in my career and I'm not afraid of the future. I would also like to thank all of my colleagues at the case company. The working community was one of the most valuable things to me in this project.

I want to also thank professor Timo Pirttilä for complete guidance in this project. His feedback was sometimes tough, but it challenged me to think differently and consider multiple aspects of performance management. I would also like to show my gratitude towards my family. My parents for being there for me and supporting my decisions. My fiancé for all the help and support through my entire studies in university and in this thesis work, especially for coping with my pessimism in finding the perfect way to write my thoughts down and waiting while I spend every minute before the deadlines to make my submissions as perfect as they can come in the remaining time.

Lahti, 27.8.2018 Sanna Vainikainen

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1 INTRODUCTION

Performance has been measured in companies for a long time, even before performance measurement or management was a real topic to discuss. Business performance has been measured unconsciously by traditional financial measures, such as return on equity and profit margin. In the late 20^th century, performance measurement became a topic to discuss among organizations, researchers and in academics. The concept of performance management (PM) was established. In the 1980s, performance measurement became a dominant term for using financial ratios as tools of monitoring and managing corporate performance. (Gautreau, et al. 2001, Neely 1999)

Soon, in the early 1980s, it was discovered that financial ratios represent a very narrow point of view when analyzing company's performance. Academic literature expressed criticism for the financial ratios on being short-term focused, ignoring customer and strategy perspectives and encouraging department optimization. (Neely 1999; Rantanen &

Holtari 1999) Kaplan & Norton (2002) explain in their book The Strategy-Focused Or- ganization that in the era of financial measures there was no need for any other measures.

The tangible assets were the most significant factor in the business world that time, so financial indicators were comprehensive and sufficient enough to measure business performance. In 1990s, attitudes changed as people realized that businesses operate in more complicated and turbulent environment where intangible capital has become the most critical competition factor. In such an environment, companies must consider different perspectives – such as competitive position and success factors, in balanced performance measurement. (Laamanen, 2005; Lönnqvist et al., 2006)

The increasing complexity of the business environment creates more and more new challenges in decision-making to the top management of a company. The acceleration in business environment change is perhaps a worn out a statement in the academic literature as continuous change in business environment can be considered the new normal in all industries. (Järvinen 2016; Laamanen 2005; Nudurupati et al. 2011; Barrows & Neely 2011). As many basic assumptions of business activities are getting older and the importance of new approaches grow, such as customer orientation, networks, ability to re- organize, a new approach is needed to manage and organize operations. Today, many

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executives expect their staff to be self-directed and to have decision-making ability that drives towards a common goal. In such changing and self-directed environment, the key to success is to invest and develop business performance. (Nudurapati et al. 2011, Jä- rvinen 2016)

The information produced by measuring the business performance is one factor in which decision-making and developing of operations can be supported. Furthermore, measuring performance communicates the organization's strategy to staff, which supports the implementation of the strategy. (Lönnqvist et al. 2016) One of the critical success factors in responding to changes of the business environment is the creation of a new strategy that is often the responsibility of top management. A new strategy and a functional performance measuring system alone do not guarantee successful implementation of the strategy, but the dedication of management and the entire staff are required to achieve these goals. This task emphasizes the importance of leadership, as resistance and fear are hu- mane in a changing environment. (Järvinen 2016) In addition to the traditional financial indicators, which look to the past, other success factors that will mirror the future should also be considered. Measurement and management of performance are nowadays done in all types of organizations and it has become more common outside its original use in production and service organizations and expanded for example to expert organizations and government owned companies. (Lönnqvist et al. 2006; Laamanen 2005)

1.1 Background of the study

The case organization of the thesis is a SME company in greentech industry. The company has enjoyed rapid growth in recent years as greentech has become more affordable and serious alternative for conventional technologies. Strong growth has led to professionalization of business practices, and higher stake holders’ expectations of quality. As the company is expecting to keep growing, it has started to develop new practices that can support larger scale of operations. As some examples of professionalization this far, the case company hired a new CEO in 2017 and moved the responsibility of operative and strategic decision-making from owner-manager to board of directors and the CEO.

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The newly appointed CEO restructured organization to functional teams and begun rolling new management practices to the company.

The assignment given by the case company is based on a project initiated to achieve an ISO 9000 series compatible quality management system. Implementation of the quality management system involves many requirements by ISO 9000 series and many develop- mental aspects have been identified in the organization's culture and operations to meet the standard. This thesis is focused solely on the company's supply chain (SC) process.

The purpose is to initiate a change in organizational culture to more customer centric, performance focused and process orientated atmosphere. Although SC is often associated with logistics and warehousing, in this thesis and in most companies, supply chain management (SCM) is seen as the core process of the company and comprehends all other supportive processes.

Performance has not been actively measured or assessed before in the organization, so the performance management system (PMS) will be created from scratch. The organization has monitored some financial figures, mostly derived from annual statements and changes in cash balance. Description of the current state is similar to Rantanen & Holtari (1999), who say that medium-sized companies utilize financial figures and financial statements derived from profit and loss accounts, in contrast to small businesses where management is often based on the owner's personal experience of his or her own business.

Unfortunately, the mere financial information represents a very narrow view of the company's past success, which can, in the long run, lead to fatal mistakes. This is an extremely important factor when considering the adoption of a PMS. The need for a performance management system is also supported by the top management to shift away from founders and by the organization's strong growth over the last few years.

This graduate thesis is written as a final proof of qualification for the master’s degree in Industrial Engineering and Management at Lappeenranta University of Technology, and it relates strongly to performance measurement. Performance management has become a part of the everyday life in SMEs due to constantly evolving, turbulent and global operating environment which requires adaptation to changes to satisfy the needs of stakeholders and the markets. (Pekkola et al. 2016).

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1.2 Research problem, boundaries and supportive questions

This is a constructive thesis with no definitive answers to research questions. The goal of this thesis is to define a PMS suitable to the case company and initiate the creation of constructive, performance focused management culture in said company. Defined PMS must be implementable and utilize an existing ERP system. This thesis is written as part of a project aiming to adopt an ISO 9001 compatible quality management system. There- fore, the outcome of this project must comply to the rules defined in ISO 9001 and support managerial decision-making, successful management of operations and continuous improvement. The dashboard-to-be-created should include sections that would be provided to the entire staff to motivate, guide, and communicate about the company's performance.

This study identifies suitable implementation templates for the design and implementation of the PMS. The main focus of this research lies in understanding the overall management system and how performance measurement can be leveraged to improved managerial decision-making. The PMS is the most tangible result of this thesis, but it can also be considered as a by-product of research in implementing a performance focused management culture. In addition to that, this thesis examines the evaluation of user experiences as part of the process of changing the methods of operation.

The Main Objective:

Defining and implementing a performance management system suitable to the case company’s supply chain and initiate the creation of performance focused, constructive

management culture.

Supportive Questions:

How do performance management systems support leadership, decision-making, and what kind of change in management culture is required to reach this?

How can performance metrics be built and what are performance management sys- tems?

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1.3 Research methodology and theoretical framework

This study is composed of theoretical and empirical sections. Theoretical research will carry out a literature review in this work, which will familiarize readers with previous studies and the literature of the discipline. The empirical part of the thesis covers examination and analysis of the case company, resulting in concrete observations from the research topic. Empirical research is carried out by interviewing organizational representatives who are the main users of the performance metrics and organizational decision mak- ers in the SC processes. The interviewees are procurement manager, a project team leader and the CEO. Discussions will be held with other team members involved in SC processes and their feelings about performance management will be addressed. Additionally, the performance meter metrics are selected together with the main users.

The study complies with the case study strategy, as it combines both quantitative and qualitative research in one business case. The case study method does not aim to make a general description of the phenomenon, but it is more important to have a profound understanding of the subject in question in its own environment. (Saunders et al. 2015 p.184- 185) It is an important feature of this thesis to generate value for the case company by solving some of the current problems in their organization. Also, a small survey is con- ducted to determine the state of management and performance before and after the introduction of a performance metric. This is part of the overall assessment of user experiences and leadership development.

A draft of PMS was defined together with top management and team managers in a workshop. Based on the outcome of this workshop, the CEO was interviewed several times to iteratively construct a company specific, strategic measurement system to aid managerial decision-making based on this draft. Of these metrics, SC measurement system was implemented as a pilot during the process of writing this thesis. As a part of this pilot, SC related operative measurement systems were also defined together with team managers and introduced to some teams. Because most employees have no previous experience on performance management, only top management and team managers were interviewed

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for this pilot. After the organizational culture adopts the concepts of continuous measurement and improvement, workers at all organizational levels will be heard to improve existing and implemented new performance metrics.

1.4 Research material

I have familiarized myself with the current organizational culture and key processes while working there as an ERP system administrator for a year and a half before starting in this project. Previously I have written a bachelor’s thesis for the same case company. I am a full-time employee there and I have a good understanding of business processes and operating principles in the case company. A lot of my research material is a product of participant observation as an active participant in the community. Acknowledging the risks of ‘going native’, objective view is maintained by member checking where portions of this thesis are sent to participants for validation and feedback. Asking participants about their intended actions helps to confirm that valid conclusions are drawn from their ob- served behavior. Many of the conclusions regarding the shift in organizational culture are drawn from my experience as a member of the target company, as well as my coffee-table discussions with team members and warehouse workers.

At Lappeenranta University of Technology, I had a SC development course, during which students solve real life issues in SCs. Outcome of this course was a written, thesis type paper a bit more demanding than bachelor’s thesis but less than master’s thesis. I wrote my paper to the case organization of this graduate thesis, relating to the same quality management system adoption program. In that paper, I defined ISO-9001 compatible process models and introduced process management and continuous improvement concepts to the case organization. This graduate thesis is an extension to the paper written on that course.

Besides formal interviews and the survey, information was also gathered through regular discussions with managers and the CEO regarding the themes presented in chapters 6.1 and 6.2. Chapter 5 is based on team manager workshops and my private discussions with the CEO. A lot of material presented in chapter 4 has come from discussions between me, quality manager and the head of logistics and procurement. Quality manager was involved

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in those discussions to ensure that the proposed PMS meets the requirements of ISO-9001 quality management standard. The unofficial discussions span over six months’ time.

Discussions began, and the first workshops were organized during the SC development course. I used them as part of my coursework, which is why those are not discussed in detail in this graduate thesis.

In total, this has been an 8-months journey, beginning with the supply chain development project during which I outlined my thesis topic and decided what to include in that course project and what to discuss in my thesis. By March 2018 I had completed the literature review and held the first workshops. I held several training sessions discussing the importance of business process management and corporate performance. Performance metrics were implemented to the ERP system in April, and in May I held more training sessions about how to use the system. Empirical part of this thesis was written mostly during the summer 2018. I decided to keep this a bit longer than usual master’s thesis project to let the case organization use performance management tools for few months and get feedback on first impressions.

1.5 Delimitations of the study

This master's thesis is limited to looking at PM in the SC context, to which the company's core business processes are related. The order-delivery process includes two sales chan- nels – project deliveries, and retail sales. In recent years, the company has been focusing more on project deliveries and co-operated with 3^rd party distributors regarding the retail business. Therefore, this master’s thesis focuses on project deliveries. Performance metrics were defined for entire organization, but trial was limited to supply chain teams and findings of this trial will later be leveraged to implement the system in other teams as well. Consequently, measurement of the sales, financial management or R&D processes will not be examined in the context of the research. This thesis briefly introduces the complete planned PMS but discusses in detail only those SC related measures that will be implemented.

Both the financial and the non-financial indicators will be taken into account in the performance measurement system. The PMS should be balanced and hence the importance

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of operational meters is important. The aim of this research is to consider the perspective of the SME, but the literature is not limited to this perspective, as the company's growth prospects support the PM for wider performance measurement. In addition, the PMS supporting tools are implemented to the ERP system, so maintaining the performance measurement system will not create additional maintenance costs.

1.6 Structure of the study

This thesis consists of introduction, five main chapters, conclusions and a summary.

Chapters two and three form the theoretical part of this thesis while chapters four, five and six are a product of author’s empirical research. Structure of the thesis is illustrated in figure 1. Chapter two discusses what performance is and how it can be managed, how target setting influences performance and what are the most likely challenges relating to PM. This chapter seeks theoretical answers to supporting question number one.

Chapter three focuses on measuring performance. It presents some theoretical constraints required to ensure the quality of measured information and presents some frameworks for defining overall performance measurement system. At the end of this chapter, the focus shifts to SC aspect, the context in which the performance management system will be piloted. Chapter explains what to consider when measuring SCs by presenting traditional SC measures and alternative ways to measure SC. Chapter tries to answer supporting question number two.

Chapter four introduces the case company and its SC processes discusses the boundaries set for PM in case company. These boundaries are quality management system and ERP system. This chapter is based on empirical observations regarding the case company.

Chapter five explains how the performance measurement system was designed and implemented. A new framework for performance measurement system was created for the case company’s needs and it is presented in this chapter. In addition to that, this chapter discusses metrics selection and performance measurement system implementation to ERP system in practice. This chapter also discusses the limitations that ERP sets to performance measurement.

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Chapter six describes the organization's management practices, in particular, how management and decision-making have changed since the introduction of the PMS. It begins by taking a view into the steps that have taken the case company to the point that they have realized the need for measurement system, and how the company has thought to be using the measures. In this context, the results of the questionnaire on user experience is also discussed, as well as the way in which leadership has developed in the organization.

The summary and the conclusions summarize the outcome of this study and elaborate on further research and development targets.

Case study

Empirical research

Theoretical background

1. Introduction

3. Defining performance

metrics 2. Managing

performance

5. Performance measurement system design and

implementation

6. Performance management practices and recommendations

7. Discussion and Conclutions

8. Summary and findings 4. Case company

and context

Figure 1. Structure of thesis

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2 MANAGING PERFORMANCE

This chapter focuses on managerial implications of adopting a performance measurement system. It seeks for theoretical answers to supporting question 1:

How do performance analysis systems support leadership, decision-making, and what kind of change in management culture is this?

The chapter begins by defining performance in business context, and then discusses how organizational culture could be tuned for performance through good managerial practices.

Goal setting theory describes how business targets could be converted to performance goals and how these goals influence short-term and long-term organizational performance. At the end of this chapter, some performance related managerial challenges are presented.

2.1 Elements of performance

PM refers to a process which’s purpose is to use indicators to determine the status of a business entity. The performance management system is based on the identification of the success factors that are important to achieve goals set to the business, measure them and use the measured information to develop organization. It is one of the most conventional tool for management and instructing. The performance management system is a tangible tool that is crucial when coordinating operations and it can be used to communicate key factors to the personnel. (Lönnqvist et al. 2006)

Several definitions have been proposed to performance management and analysis. Ac- cording to Rantanen & Holtari (1999) the company's performance can be defined as its ability to produce outputs with set dimensions in relation to the set goals. Many other very similar definitions arise from literature. At the most basic level, performance can be understood as Lönnqvist et al. (2006) states it to be performers ability to reach set goals.

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Rantanen & Holtari (1999) represent in their report seven components of performance.

They are:

• Effectiveness, that is the degree to which the system accomplishes what is set out to accomplish.

• Efficiency can be described as the relationship between the planned run-in and the actual run-in, i.e. the fact that the system has used the right things.

• Quality is the system’s ability to fulfil users (customers) needs and expectations.

• Profitability represent how effectively financial resources have been used.

• Productivity tells how the output is proportional to the amount of inputs used. It describes the performance of a company's real process in converting inputs into production outputs.

• Quality of work life is the way participants in a system respond to sociotechnical aspects

of that system.

• Innovation describes the ability of the company to create reforms.

Ability to perform can be understood as information gained by measuring the output of an organization, a process or an employee. This information is interesting and useful for corporate management if, and only if, it can be taken advantage of to improve decision- making, gain a larger market share, or improve processes, products or human knowledge.

PM is also about taking responsibility. Without responsibility and control, no decision, action or learning can be achieved through this information. (Laamanen 2005)

Both Rantanen & Holtari (1999) and Laamanen (2005) point out the basic breakdown of performance into two main areas. These areas are external and internal performance. They describe that external performance focuses on external accounting and is based on looking at the company and its performance. External performance evaluation and measurement can be performed by an external party or by the company itself.

One challenge of external performance analysis may be that an external party may not have all the information and data needed for calculations. That’s why external performance analysis is often based solely on publicly available information. Measurable items may be, for example, financial performance, which makes it more difficult for an outsider

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to obtain the same high-quality information as if it were the company itself. An external analyst can, for example, act as a stakeholder group, such as financiers. Analyzing external performance is the most commonly seen as company’s financial statements analysis.

(Laamanen 2005, Rantanen & Holtari 1999)

Internal performance refers to the performance within the company. In this case, the analysis is often carried out by the company itself. Usually, the company also has clearly better and more accurate information than an external reviewer in external accounting.

When external accounting looks at the company, internal accounting divides the company into parts to evaluate and measure the performance of individual departments or functions. Some stakeholders in the company can also analyze their internal performance. For example, the financier may have sufficient information to analyze the internal performance when making the funding decision. Generally, representatives of the company are required to provide this information to the sponsor upon request. (Rantanen & Holtari 1999)

The most important components of internal performance are productivity, efficiency and economy. Analyzing quality, delivery time, lead time, and capacity are also important areas for internal performance analysis. The internal performance analysis therefore focuses on looking at the parts of the business and analyzing the performance or the result of a single machine or person at its most detailed. Internal performance analysis often utilizes information produced by internal accounting, especially cost accounting. There are no similarly established accounting methods or guidelines for cost accounting or more widely available accounting policies for management accounting purposes than those used for external accounting analysis. Every company can use the meter that they want and the best fit in the different metering situations. (Rantanen & Holtari 1999)

Performance can be analyzed at several different levels. A kind of base division may be a structure in which the analysis is divided into two levels which are society and organizations. (Neilimo & Uus-Rauva 2009; Rantanen & Holtari 1999) Society can be analyzed at economies, sectors and at the corporate level. Those levels are high above corporate level and they very seldom used in corporations.

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According to Neilimo & Uus-Rauva (2009), organization level can be divided into more detailed examination levels such as:

• Profit centers

• Departments and Functions

• Processes and Occasions

• Groups

• Individuals

Different parties may emphasize only a certain level of performance in their performance measuring. To be able to develop productivity broadly, society and its organizations must focus on the performance of all levels affecting the outcome. Generally, performance is created at lower levels, while the upper levels influences the prerequisites for productive business. The performance is closely related to the concepts of productivity, efficiency and profitability. Improving the productivity of a company usually means, directly or in- directly, that the company's cost development slows down, price competitiveness improves, ability to pay improves and structural changes take place. The decline in productivity, on the other hand, has the opposite effect. The rise in productivity may also mean a decline in jobs, particularly in industries where there is no growth. In these situations, productivity can be increased, for example, by automation. Just like performance, productivity can be defined as the relationship between the outputs of a viewed subject, i.e. the systems throughput, and the inputs placed to the system, i.e. input per output (figure 2).

(Neilimo & Uus-Rauva 2005)

The size of an organization has a great impact on the need to measure business performance and to the challenge of measuring performance. In small organizations that are usually led by the founder, entrepreneur’s responsibility is clear, and decisions are fast made by the entrepreneur because he or her is very aware about what's happening in the business environment and business. In medium sized organizations activity is based on functions and sharing responsibilities. In a mid-sized organization, managing various

Figure 2 Components of productivity (Neilimo & Uus-Rauva 2005)

System Output

Input

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tasks requires different know-how. Important tasks are hired to be taken care of by pro- fessionals instead of enthusiasts. As the size of the organization grows, more and more information produced by measurement is needed to measure different functions and company when management is increasingly excluded from the operative action. In large companies’ performance measurement is a vital operation for decision-making and management. Also finding the information needed for management in large organizations is much more difficult than in smaller organizations. (Laamanen 2005)

Performance is often seen as a very multi-dimensional issue influenced by many factors (Pekkola 2006). One key factor is to identify the most important stakeholders and their needs. Usually, a shareholder is of great worth if they get a share of the process results, or they play an active role in the activities development. Developing performance management information based on stakeholders’ interests enables evaluating whether tactical plans are being met and it provides a means of testing the presumed cause and effect relationships between the measures and strategies. (Franceschini et al. 2007) A company can be seen as a system of collaboration, that strives to meet the objectives set for it. The objectives of different stakeholders can be very different, e.g. owners emphasize return on equity and employees value regular pay and stability in working environment, so the performance can be understood differently. Likewise, different parts of an organization may have contradictory goals. For all stakeholders, the common goal generally appears to be the ability of the company to efficiently generate revenue, i.e. profitability through cash flow. (Lönnqvist et al. 2006; Pekkola 2006; Rantanen & Holtari 1999)

The company must be able to cover the income of all key stakeholders with reasonable requirements. The most traditional stakeholders are owners, managers, employees, customers, suppliers, financiers and public power. At least in the long run, failure to meet the requirements of a key stakeholder may lead to a stakeholder withdrawal from the company, and hence, disruption of the business. Excessive emphasis on an individual stakeholder or dimension may be a dangerous approach. In short term, it can maximize success with respect to that dimension, or in the eyes of that stakeholder, but in the long term, the whole suffers. For example, short-term maximization of the profit announced in the interim reports and the increase in the value of the share can haunt the company in the future through neglected investments and research and product development. However,

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many of the most successful companies struggle to consider their stakeholders interests balanced. (Laamanen 2005; Rantanen & Holtari 1999)

Performance measurement is one of one of the most common management processes used to evaluate, analyze, control and manage business. (Rantanen & Holtari 1999) It is an important part of instructing and controlling activities, as it systematically quantifies information so that more informed, rational decision-making can take place. In addition to that, performance measurement can be used to communicate the important matters to the employees. Managerial reasons for performance measurement may be summarized as follows: (Karhu 2005).

• Guidance

• Planning

• Monitoring

• Alerting

• Diagnosis

• Learning

• Informing

• Recompensing

PM is about the information gathered though measurement. It tells how an organization, its process, its products or individuals performs. This information is then used to decision- making to make the organization create new, develop employee know-how, intensify processes and grow market share. The prerequisite of PM is responsibility. Organizational performance that is nobody’s responsibility is not useful because decisions, action or learning does not happen without ownership, commitment and responsibility. (Laamanen 2005)

2.2 Management culture

Managing the company is often described as a cycle of planning, implementing the plans, monitoring the implementation and, if necessary, correcting the direction of the business.

The definition is derived directly from Deming's PDCA cycle, which can be used to look at the management process. Depending on the views of the author, management can be

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defined in very different ways. Traditionally, PM and measurement are about strategies, processes, and critical success factors. (Laamanen 2005, Ukko et al. 2005)

Measuring performance is about measuring performance, where performance is the result of human activity. Therefore, while designing, implementing and using the performance management system it should be inevitable to consider the personnel using it. Some authors refer this with leadership to make distinction between managing people and managing issues, to which they refer to with management. Leadership can be understood as a process or action that effects a group of people while they strive towards their goals. A visionary leadership can be described like a process illustrated in figure 3. In leadership it is indispensable to motivate, commit and to involve employees. Performance management system is a way to communicate company’s vision to its employees and whole organization. (Ukko et al. 2005)

Bititci et al. (2004) found out that organizational culture, leadership style, and performance measurement have a strong influence on each other. Successfully implemented PMS leads to more participative and consultative management style. Use of performance management system leads to better corporate performance and refines organization towards the culture of achievement. They also discovered that performance measured should be seen as a cross-functional issue. It requires joined-up thinking at all levels of organization.

When designing a PMS, it must be pondered at which organizational level measurement is to be performed and at which organizational level the objectives are set. The top management is responsible for deciding which decisions can be carried at which organizational level. These decisions must be made carefully because they affect PM. The top management makes decisions about strategy and lower management sets operational

Performance measurement

Vision (idea) Communication Action

Figure 3 Leadership process

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measures, but the role of employees in objective setting must also be considered. This is important since participating employees in setting objectives related to their own work makes it easier to commit them to these objectives. (Ukko et al. 2005)

Kaplan & Norton (2002) highlight their book that performance measurement is essential when communicating company’s vision. And therefore, it is not possible to communicate vision if measures are displayed only to the top management. According to Kaplan &

Norton (2002), companies should see the implementation of a strategy the same way as they understand launch of a new product. Companies should use the same effort to communicate new vision to their employees as they do in marketing to the customers. The first step is to educate employees, then testing the stage of understanding the strategy and lastly to evaluate how employees obey new strategy and even teach it to everybody else in the organization. The whole process should accordingly be resourced and budgeted.

The idea is to understand that it is the point to command from the top to bottom. The question is about communication from top to bottom. In the latter case it is possible for employees to find innovative to help the organization to achieve its strategic goals. As researches show, communication has a significant impact in organizations success. If employees do not understand strategy, they are not able to execute it in their everyday work.

To create a high-performance environment in a company trough performance management, PMS must create relevant and visualized information. Generally, graphs and gauges are better visualization tools than tables. Successful visualization enables the dissemina- tion of measurement results. (Robson 2005)

Motivation stands for a state of mind caused by motives. Other definitions state that motivation is state of an individual that defines the stage of activity and diligence in completing tasks or that motivation is employees’ consciousness about set objectives and has enthusiasm completing the set objectives by using own resources in an appropriate way.

High motivation is often derived from a job that suits the employee and corresponds to personal interests. Motivation is traditionally divided into two aspects: internal and external motivation. Internal motivation is usually high if work is done because of its property of being challenging. External motivation is usually created via financial incentives that can affect working positively. Still incentives only remove dissatisfaction and seldom creates complacency or high motivation. Also, the use of incentives must be balanced.

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Too much of incentives creates a negative effect on efficiency. That is why balancing internal and external motivation is essential in leadership. Research has proven that work motivation is related to performance and quality of work done. That is because motivation creates more effort and dedication into tasks. Other aspects that affect working motivation positively are: (Pekkola 2006)

• Clear objectives that are measured and possible to achieve

• Evaluation of results that is done regularly

• Feedback that concentrates on actions and results

• Positive guidance

• Actuate salary

• Varying work that is challenging and self-driven

• A suitable amount of work over time

The development of a PMS requires the continuous involvement and commitment of the top management to the process. Business goals are derived from the company's strategy and one purpose of performance measurement is to follow the implementation of the strategy. This strategic vision can only be developed by the top management of the company. The development of PMS is a task that cannot be assigned to a lower management or consultants alone. When company’s top management is involved in presenting a PMS to lower levels of hierarchy, it is easier for employees to accept change. The role of the management is especially emphasized when a company is starting a systematic PM through an organized measurement system. In this case, the top management should clearly express their support for the change process. The introduction of a PMS in an organization where performance has not been measured before is a major change in the work environment. It requires a whole new way of thinking, especially when there is no previous PM experience. Creating this new way of thinking is at the forefront of the top management, as lower levels or an outside consultant may not be strong enough as au- thority to assure the importance of the matter. Especially in SMEs the activity of the top management, CEO or owners rises into even more high importance. (Tenhunen 2001) Tenhunen (2001) also explains the importance of committing the employees to the PMS.

Again, if PM is a new concept to the organization, it is justified to deal with the role of

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the staff from the point of view of the change process. It this case it is essential to commit the key persons to the change and to get the employees prepared to the change coming.

A team leader should discuss with his or her team’s key persons about their teams working culture and its influence in hands-on working. Discussions should strive into a mutual understanding of team’s key values and a vision how their working culture can be improved to respond to the changes in business environment. After this the conversation can be moved to lower levels of hierarchy, where should be discussed the pressure that influences working and what actions that causes.

According to Järvinen (2016), performance is determined as a product of dedication, action, know-how and potential. First two of these are strongly related to motivation, and the latter two to training. Dedication and willingness to act separate the good from the excellent, but neither of those two factors affecting performance can be improved through training. Potential refers to the capability of learning new skills or improving existing ones, and skills and capabilities set the upper boundary to current maximum performance.

They describe know-how as a collection of skills and capabilities combined with ability to target them into something useful. In modern environment, especially following skill- set should be trained to achieve higher performance.

1. Relaxedness - the ability to perform without over-stressing 2. Optimism - right type of discernment in tough times

3. Multitasking - concurrent, parallel execution of multiple tasks

4. Ability to stay focused - understanding what is relevant and what is not 5. Impressiveness - ability to influence other people

6. Dedication - ability and desire to do productive work as a part of a work community 7. Giving up - ability to let go at the right time when change is required to survive People tend to say that you get what you measure or measure what you want to lead and encourage. However, leadership is always done through people. Leadership is influenc- ing, pursuing and achieving excitement and interaction with people. It must remain in- spired and encouraged. In the best case, PM and measurement create positive effects in the work community.

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According to Neilimo & Uus-Rauva (2005), they

• Motivate

• Emphasize the value of the matter that is measured

• Guide to do the right things

• Clarify the objectives

• Create healthy competition

• Improve communication

• Create a prerequisite for incentive schemes

At worst, measurement can cause the reverse effects of the positive listed above. In this case, measurement will cause organizational personnel to become annoyed, enable part- optimization, stiffen the organization, and create bureaucracy. (Neilimo & Uus-Rauva 2005)

Quality focused companies are more likely to encourage the use of PMSs, and without clear strategy, it is hard to find the right things to measure. Organizational culture partially determines the effectiveness of performance management systems, yet it is unclear what type of culture is the most beneficial and how this culture can be created. Environment and industry characteristics likely affect the use of PMSs, but most authors have relied on vague assumptions with no further research on how contextual factors should, by common sense, affect the way organizations deal with these systems. (Franco-Santos &

Bourne, 2005).

Effective implementation of processes ensures better understanding of causal relations in business operations – to improve performance, it is essential to be able to separate the vital key processes from the trivial. When managers understand the need for change, the next step is execution. The challenge in execution is that performance usually drops mo- mentary. If managers give up on change initiatives now, change process will stop and employees fall back into old habits. (Laamanen, 2005).

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2.3 Management practices

Management trends come and go, like fashion. Usually these trends are characterized by a guru, an external consultant popularizing the trend. These fashions are experienced as rapid, bell curves in the popularity of management techniques. Some may even call them fads, as they gain popularity by offering quick solutions to complex problems and after wide adoption problems emerge, after which quick decline in adoption rates begins. Yet these trends enrich management culture as companies retain the positive factors from these trends. In 1980s, Quality Circles was one of these trends, as around 90% of Fortune 500 companies adopted this method. By 1987, 80 percent of these companies had aban- doned the method. However, several timeless key concepts remain at the core of business management. (Abrahamson, 1996).

• Understand your core business

• Measure strategically important things

• Improve performance by optimizing your processes

Bourne et al. (2005) studied the performance impact of managing through measures by comparing the operating principles of several similar business units. Balanced Scorecard (BSC) was used not so much to maximize performance but rather to ensure meeting established standards and alert when actions must be taken (a traffic light in IT system).

Active communication between managers and workers as well as collaborative planning in continuous development was identified as the most significant success factor separat- ing the good from the average. Profound understanding of business operations and the connections between people, processes and performance helped exceptional team managers reach higher performance compared to the average managers.

Anitha (2014) surveyed factors of employee engagement and their influence on employees’ performance. His findings suggest that team and co-worker relationship together with working environment are the most significant factors of employee engagement. Less important factors include leadership and workplace wellbeing. He found positive correlation between employee engagement and their measured performance. Although somewhat difficult to objectively and accurately measure, these soft factors should also be considered

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in PM. Similar findings have been made by Gruman & Saks (2011). Harel & Tzafrir (1999) noted that training was the most important success factor determining the market performance of large Israeli companies.

As Kaplan & Norton (2002) appointed the importance of communicating the company’s strategy, they also provide in their book few examples how effective communication can be carried out in the organization. They propose:

• Quarterly meetings

• Brochures

• Monthly handouts

• Teaching routines

• Intranet

Richards (2014) lists some best practices for efficient communications when introducing performance metrics to employees:

• Use terminology that your staff can understand and that is meaningful to them

• Understand what your staff needs to do to improve service or reduce costs

• Use common industry KPIs to enable benchmarking

• Review the data regularly and look for trends

• Not overreact to a particular data point

• Only introduce cost-effective metrics

• Not measure what you cannot change

Neely (1998) talks in his book about aligning measures and strategy. In his opinion for most organizations it is the most difficult part in measurement that their measures are not aligned to the business’s strategy. The linkage between measures and strategy is discreet but important. If measures are linked to strategy they provide information whether the implementation of the strategy is successful or not. It also helps to encourage behavior that is consistent to strategy. Both Lönnqvist et al. (2006) and Kaplan & Norton (1996) encourage companies to create a strategy map for both general management and performance management reasons. Strategy maps are important when implementing a strategy- based measurement system such as BSC. Strategy map is a visualization of organization's

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strategy through the causal relationships between measurable success factors (Figure 4).

The strategy map works as a graphical model of the organization's strategic goals and their connections. In practice, the map should help to identify the event path followed by achieving strategic goals. Strategy map is considered as a tool to manage the overall strategy and an example use case may be the executive board discussions of the success of the strategy. Strategic mapping can also be considered useful in the construction of a PMS as identifying relationships between success factors is essential when constructing business performance management system.

Profitability Growth

Continuity conspicuousness

Customer satisfaction

Estimates

Price Expertise, Quality, Service Schedules

Productivity Profitability Know-how Schedules Accuracy

Work environment Developing a job description, salary, expertise Customer

Economy

Employees Processes

Figure 4 Strategy map (Lönnqvist et al. 2006)

2.4 Goal setting theory

Traditionally, goals have been grouped into four classic categories in goal setting theory.

These levels are do-your-best, easy, difficult and impossible. Rewarding employees for achieving goals has been proven to increase individual work performance by Locke &

Latham (2002), who define four distinct mechanisms through which goals affect performance. These mechanisms are directing attention, energizing and improving effort, affecting persistence and discovery, and use of task-relevant knowledge. Generally speak- ing, harder goals make people work harder and longer, as well as find new ways of doing

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things more efficiently. Similar effects can be achieved by gamification. Landers, Bauer and Callan (2017) illustrate the use of leaderboards as a means of improving performance.

First, they demonstrated the performance increasing effect of those four classical levels of goal-setting, by showing that impossible goals yielded the highest performance in given tasks. However, when public leaderboards were introduced, and the performance ratings of others revealed, all participants aimed for the top positions in the leaderboard even though they were not asked to do so. Even the ones with the lowest initial targets aimed to the top spot previously occupied by some of those who were given the impossible targets.

Although setting higher targets definitely has performance increasing effects, Welsh &

Ordóñez (2014) argue that consecutive high-performance goals also have a dark side of increasing depletion and unethical behavior in employees and managers. They also note that decreasing goals have the exact same effect on unethical behavior, but a dwindling effect on depletion rating. Setting consecutively increasing goals or “do your best” goals have much more modest impact on the amount of unethical behavior and the number of burnouts.

For overachievers, individual performance assessment is like throwing gasoline into a fire. While it improves organizational performance in short-term, it is exhausting and will likely burn out these talents in longer term. In sales division, it also prevents teamwork as individuals are only concerned about their own sales figures. In some cases, salespeo- ple may try to steal leads from other people to increase their own performance ratings.

Measuring in too much detail may lead to micromanaging, where managers begin to look excuses for random changes and try to solve issues that do not exist.

When used for planning purposes, targets should be set as realistic as possible, indicating the best guess with equal probability of over and under estimation. This gives managers best baseline for planning the operations, as they do not need to compensate with excessive hoarding of resources to meet objectives set at the most optimistic level. At worst, impacts are similar to bullwhip effect in poorly managed supply chains. For motivational purposes, targets should be communicated to be at a higher than actual level. This pushes employees to try harder to meet the target, especially if there’s an external reward for

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reaching the target. However, impossible targets decrease motivation as there is no point on trying if the employees are sure they will fail to meet the target. (Merchant & van der Stede, 2016 pp 309-318).

Measuring individual performance may limit the performance if targets are set based on previous performance. Workers quickly learn to protect against poor performance ratings by settling to meet the target or slightly exceed it, as this makes the target more reachable next year. In case of poor performance, verbally gifted, selfish and bogus employees may try to find excuses for it. This prevents from tackling the real issues behind poor performance.

The performance measurement gives a good base for fair and evenhanded rewarding system. As discussed in the motivation section, incentives tend to effect on motivation and it further affects quality and efficiency work is performed. As it is well known in organizations nowadays, employees are one of the most important competitive factor in companies. Scholars emphasize the importance of employee resources. Employee strategy is the only real way for companies to create competitive advantage as resource perspective.

Other, more traditional competitive advantage factors e.g. production technology and economies of scale are relatively easily copied, so competitive advantage can be reached only by factors that are more difficult for competitors to get. (Karhu 2005)

Cascio (1986 pp. 360-370) discussed linking compensation strategies to business strategies. He identified three distinct strategies companies go through during their life cycle.

In invest to growth strategy, individual talent is vital in determining the future of the company. Usually the number of employees is rather low in this stage, and performance of few key employees or business units dictates the overall performance of the business. In this phase, entrepreneurialism should be stimulated with above-average incentives for individual performance. As the business exits rapid growth phase and reaches maturity, it often enters manage earnings, protect the markets strategy where management skills should be rewarded. Individuals are not as centric to business performance anymore, and moderate incentives should be set for individual, unit or corporate performance. As the market eventually declines, companies enter harvest earnings, reinvest elsewhere strategy. Cost control is key here to postpone the eventual closure of declining operations.

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Employees should be given below-average cash compensation with small incentives tied to cost control.

Setting the performance targets explicitly enables efficient and transparent communication as well as rightful and inspiring compensation schemes. Managers have clear responsibilities and can influence their own compensation by their actions. It is easier to detect issues and react accordingly when development of performance is constantly monitored.

With the generated information, organizations can learn and improve. By constantly monitoring customer satisfaction, company cannot get too detached from its customers. With concrete information to present about corporate performance, shareholders are more likely convinced about the company’s ability to generate value.

2.5 Challenges and different approaches to performance management

According to Ukko et al. (2005) decision-making is essential part of managing. Managing can be seen consisting of three sections that are detecting the decision-making situation, identifying the operating model and deciding the operating model. PM especially helps to the first section, detecting the decision-making situation. These situations can emerge when certain measured matter does not meet desired position/rank. Even though performance management systems give information needed to detect objects that require improvement, it doesn’t tell directly what to do or what the options are in that situation. The success of management depends on how the information got from measurement system is used to make decisions and if the decisions made are right, management can be considered successful.

Choo (1996) divides the use of information into three distinct categories. Companies can use information to support decision-making, sense operating environment and to support organizational learning e.g. creating new ways of doing things or inventing new business opportunities. In theory, all decisions should be made based on all available information and careful evaluation of potential implications of these decisions. In practice, decision- making involves balancing between interests of organizational stakeholders and making decisions under uncertainty or imperfect information, jumbling rational decision-making processes.

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In addition to Choo’s article, Laamanen (2005) identifies few more information needs for companies’ top management.

1. Needs of stakeholders and competition 2. Resource allocation

3. Process efficiency 4. Achieving change

Information according to stakeholders and competition is one of the most important because all the stakeholders expect to benefit from the company. Each stakeholder group’s objectives and needs may vary, e.g. shareholders and customers have very different interests. Giving benefits to stakeholders may happen all naturally in companies because companies tend to strive into profitable business by giving customer the product or service they are willing to pay for. Still varying need of stakeholders may cause situations where it is difficult to balance between the interests of stakeholders. Resource allocation is one of the most traditional balancing problems among managers. (Laamanen 2005) Franceschini et al. (2007) note that care should be taken in interpreting the measures. As stated in agent theory, agents i.e. actors, will interpret the definitions of indicators in a way that is the most favorable and aligned with their self-interests. That is, if the definition leaves some room for interpretation, numbers will be biased towards better than actual performance. Detailed, process level indicators are likely to yield cost shifting rather than actual cost savings, when costs are rolled to other processes and business units to make the own unit look more favorable.

Misinterpretations of performance indicators are common, especially when indices are used. If multiple measurements are combined into a single number, the meaning of this number can easily become blurry. Aggregating data from several sources is an effective method of compressing complex information to a more easily understandable format, but it may bias the results if the original data is not properly standardized. Numbers are easily manipulated, and the risk of manipulation increases when compensations are tied to a performance index. People are more easily convinced, if numbers are used as a basis of an argument. However, numeric measures should not be trusted too much without understanding the source, potential limitations and possible biases. (Laamanen 2005)